Accounting in the News Spring 2013

In order to extend an equipment or aircraft’s useful life, there were only a few possibilities for Delta: route changes, maintenance, and/or betterment through more efficient technology.  Delta, has taken many routes in order to increase their profits very efficiently.  Since acquiring the transatlantic from bankrupt Pan Am and later acquiring Northwest Airlines after they rose back from bankruptcy, Delta has acquired many aircrafts and equipment from other airlines.

Delta’s new approach in cutting down the size of their flights to be more cost and fuel-efficient has been one of their many ways of approaching their increasing debt and increasing fuel costs.  An article published in 2011 shows that Delta has put in orders for Boeing aircraft MD-90 that were previously owned to come in during 2013-2017 through a financing program.  These flights are more narrow and have less number of seats which and are more fuel efficient.  In doing this, Delta believes they will be cutting down their maintenance costs and fuel costs.  Fuel consumption took a huge toll on Delta’s revenue in 2011; their annual report shows an increase of nearly $2.9 billion from 2010.  Also, from the annual report, it is clear that Delta still performs more on domestic flights than international, therefore depreciating their aircraft sooner than if they had more international routes.  Their long-term debt seems to be forecasted to be increasing due to this financing with Boeing, co., however it is not evident that Delta would be making enough revenue to cover their obligations and costs, and attain marginal profits from the change in their strategy.

Another article published in 2012 explains Delta’s interest in lowering these fuel costs by buying a refinery.  Through this Delta expects to have fuel savings of nearly $100; fuel costs were a major factor in Delta’s annual report of expenses and cost increase from previous years.  Delta expects this new partnership with Trainer refinery to increase their margins and recover within the first year of operations once this falls into full act.  We will have to take a look at Delta’s 2013 annual report to determine the benefits of this partnership in 2012.

Both the partnership and purchasing older flights (MD-90) to save per unit costs so that Delta can pay back their debt may not be a realistic approach to their current situation.  By purchasing older planes, Delta may be trapped in increased maintenance costs.  The useful lives of these planes are less, therefore reaching their salvage value sooner than other planes.  Maintaining these planes may actually cost more in order to increase their useful lives than purchases newer plans with initial high life expectancy.  Especially due to Delta’s often domestic routes, the flights are more likely to have maintenance problems, increasing their operational costs more.  Boeing expects to come out with more efficient engine aircraft by 2017, which Delta was not interested in at all to save their expenses.  Delta’s “penny-pinching” investments in their aircraft may end up working against them if the older aircraft die out sooner than their given expected life.  The refinery partnership however may work in their favor to lower fuel costs, however I do not believe that they can make higher margins.

SOURCES:

http://online.wsj.com/article/SB10001424052702304050304577376354288927594.html?KEYWORDS=Delta+refinery

http://online.wsj.com/article/SB10001424052970203406404578072960852910072.html?mod=WSJ_article_comments#articleTabs%3Darticle

http://www.annualreports.com/Company/511

http://online.wsj.com/article/SB10001424053111904875404576530340951416116.html?KEYWORDS=Delta+aircraft

LBBB (Liberty Bell Bank) is a full-service, state-chartered commercial bank and provides diversified financial products through three locations in Burlington County, New Jersey and one location in Camden County, New Jersey. On April 16, 2013, it announced its earnings for the first quarter of 2013. The reported net income was $202,000, a $167,000 increase from net income for the same period of last year ($35,000). The report explains that one primary reason for this substantial climb in net income is the gains on the sale of available-for-sale (AFS) securities ($156,000).

As we have learnt, this sale would have following impact on the financial statement of LBBB:
1. It decreased the “investment securities” under current assets on balance sheet.
2. It brought down the unrealized gain under Shareholder’s equity on balance sheet.
3. It increased the realized gain on income statement.

In addition, the report also disclosed that interest income for AFS securities increased $54,000 in the first quarter. This interest income, same as dividend from AFS securities, was recognized on income statement immediately. Unlike revaluation of AFS securities, unrealized gain/loss is recorded under shareholders’ equity on balance sheet and the realized gain/loss is ONLY recognized on income statement when the securities are sold.

For more information, please see the article: http://eon.businesswire.com/news/eon/20130416006787/en.

Most Airlines prefer new planes with low fuel consumption and the latest high-tech gadgets. Delta on the other hand in an effort to cut costs, has focused on an asset most airlines avoid – older planes, It now has one of the oldest fleets in the U.S. and is making a habit of using or buying older planes.

Besides the MD-90s it purchased in 2012, Delta has picked up the leases on 88 Boeing 717s, with an average age of 11 years, from Southwest Airlines. Surprisingly, even with the planes’ higher fuel consumption and maintenance costs, Delta figures it is saving at least $1 billion on the MD-90 purchases, compared with buying new planes. Regarding the 717’s Delta fleet executive said he is “thrilled about the deal we got.”

Although safety experts used to fear old planes in the past, most say now that “with careful maintenance, older jets can fly safely”. Boeing has showed that only 12 of 36 commercial jetliner accidents in 2011 that destroyed planes or caused substantial damage involved aircraft 20 years or older.

At the heart of Delta’s older fleet strategy is its 2.7 million-square-foot complex of maintenance hangars and shops at Hartsfield-Jackson Atlanta International Airport. With its mechanics having 19 years of experience on average, Delta believes it has the built-in expertise to care for its aircrafts.

Thus, by having great maintenance, Delta is able to increase the useful life of its aircrafts. John Enders, an aeronautical engineer and aviation safety consultant, allowed that airplanes “have no practical end date.” But older planes require an “extremely careful inspection and maintenance system,” he said.

Source:

http://online.wsj.com/article/SB10001424052970203406404578072960852910072.html

This article takes a look at how JPMorgan Chase & Co. managed to offset their second quarter losses using marketable securities. JPMorgan realized a $2 billion loss, mainly from it’s derivative trading securities, so far in the second of 2012. To help offset these losses, JPMorgan looked to sell some of their available-for-sale securities that have produced cumulative unrealized gains they were purchased. Thus far in the second quarter of 2012, a $1 billion gain was realized from JPMorgans sale of available-for-sale securities and many investors believe that this is not a coincidence.

Since the change in the fair value of a trading security is recorded in retained earnings on the income statement, the gain or loss from this security is seen immediately. However, the change in value of an available-for-sale security does not affect net income until the security is sold. The change in fair value is only seen on the balance sheet (accumulated other comprehensive income – stockholders’ equity) So, companies can classify any security, no matter how volatile, as available-for-sale and keep the accumulated gains/losses off the income statement.

Selling available-for-sale securities to offset losses is not unlawful under FASB, but it does complicate financial reporting and makes it difficult for investors to determine the current intrinsic value of the company. Additionally, a company that is having a poor quarter may sell their most promising long-term securities in order to offset their losses. The author is pushing for FASB to make companies earnings a little more transparent by not allowing companies to have a “holding tank” where they can offset losses by selling promising investments, and I agree with this proposition.

Source: http://www.bloomberg.com/news/2012-06-21/jpmorgan-s-profit-is-scarier-than-its-loss.html

A company similar to Chemical Financial Corporation is First Federal of Northern Michigan Bancorp, Inc. (FFNM). It too is a Michigan bank holding company operating.   FFNM released its 2012 results last month.  Unfortunately, the company had a net loss of $214,000.

Within their financial statements is an Available-for-Sale Securities adjustment for a year-over-year unrealized gain of $79,000.  This is interesting because if instead of Available-for-Sale Securities they had been classified as Trading Securities this unrealized gain would have been recorded as earnings. While it would not have fixed their net loss since this was an unusual loss for them (they had net income of $742,000 in 2011), this could have put them in a better position.

In most instances choosing to classify a security as either trading or available-for-sale is subjective.  This is because classification depends on the intentions of the company, which only the company really knows.  With available-for-sale, securities’ unrealized gains and losses are recorded under Shareholders’ Equity.  Trading, however, is recorded within Retained Earnings.  By classifying securities as trading a company can increase their earnings by reporting unrealized earnings, which could put them in a better position.  Therefore, if FFNM had classified these securities as trading instead of available-for-sale they would have had a smaller loss for 2012. However, it understandably can also have the opposite effect.  For if the securities had instead had an unrealized loss then it would have hurt FFNM even more.

For more information, please visit: http://www.marketwatch.com/story/first-federal-of-northern-michigan-bancorp-inc-announces-fourth-quarter-2012-and-full-year-results-2013-03-22.

Any security acquired by a company is classified at the time it is purchased depending on the amount of the security purchased or the nature of its lifetime. If we have the intent and  time to hold the security until maturity, it is classified as held-to-maturity. Securities to be held for indefinite periods of time, but not necessarily to be held-to-maturity or on a long-term basis, are classified as available-for-sale and carried at fair value with unrealized gains or losses reported as a separate component of stockholders’ equity in accumulated other comprehensive income, net of applicable income taxes. Realized gains or losses on the sale of securities are determined using the amortized cost of the specific securities sold.

In order to incorporate the changes in market price of securities, companies have to make adjustments (unrealized gain/loss) to their financial statements at the end of each accounting period. For AFS (Available-for-sale) Securities, these changes are usually done quaterly, semi-annually or annually.   With changes in market value of available for sale securities, considerable changes can be noticed in the financial statement particularly Balance Sheet i.e. Shareholders’ equity section. The only time securities actually effect the cash flow statement, apart from the time they are sold are when interest income or dividends are recognized. To see the impact of market valuation on the financial statement of a company, we consider the current quarter returns announced by JP Morgan chase.

JP Morgan Chase recently announced its numbers for the first quarter, with record amount of net income of $6.5 billion.  Net revenue has been recorded at $113 million compared with a $233 million loss in the previous year. Net revenue included net securities gains of $503 million from sales of available-for-sale investment securities during the current quarter. Net interest income was a loss of $472 million due to low interest rates and limited reinvestment opportunities.

More details: http://www.fiercefinance.com/press-releases/jpmorgan-chase-reports-record-first-quarter-2013-net-income-65-billion-or-r

Bad debt occurs when credit sales are not collected as cash. Each industry has its own “normal” level of bad debt as a proportion of total credit sales. For banks, the allowance for bad debt is an account created to estimate the amount of a bank’s loan portfolio that will be ultimately uncollectible. It is also known as “loan-loss reserve”.

The Bloomberg article discusses the recent increase in bad loans at Italian banks. The amount of bad loans achieved its highest level in more than 12 years due to the deep and long recession. This is caused, primarily, because hundreds of small companies are forced to go out of business each day and families are struggling to repay their debts as unemployment rises.

Non-performing loans increased by 18% last year to $163.3 billion and it is expected that bad loans amount keeps rising until the economy starts to recover.

Sources: http://www.bloomberg.com/news/2013-03-19/italian-banks-bad-loan-ratio-rises-to-highest-in-12-years.html

It’s been a very hectic three years for retailers. Back in 2008, discretionary spending was down amid greater concerns of a failing economy. Target felt this uncertainty, as seen on their “bad debt expense.” As the retailer saw its third-quarter earnings fall a whopping 24%, it attributed the loss to a higher bad debt expense. Its annual reports stated that the figure, which estimates the amount of uncollectable write-offs it would encounter in the next period, increased about three-fold from 2007 to 2008. Posing a bedeviling problem, the bad debt expense seemed it would linger for as long as the industry-wide credit deterioration would.

It wasn’t until 2010 that Target would see the bad debt expense go down–by nearly 90%. After clearing out its cadre of not-so-receivable receivables, cardholders began to pay down their unpaid credit. This resulted in a decrease of bad debt expense from $138mil in 2009 to $15m in 2010.

Retail consultant at AT Kearny Laura Gurski also attributes the drop to retailers like Target now learning how to manage inventories and delay markdowns. By keeping their inventory priced higher for longer, Target, among other retailers, can retain higher margins. Obviously, the downside to that practice can be the price-sensitive customers who refuse to buy items not on sale.

Furthermore, relying on customer solvency (and therefore credit solvency) to rescue Target’s receivables was a risky move in and of itself. Had the consumer credit crisis lasted longer than it had, Target’s writeoffs would only be exacerbated. There simply cannot be enough said for the effect that the recovery in customer sentiment had on earnings, regardless of how well the firm manages their inventory.

Source:

http://media.corporate-ir.net/media_files/irol/65/65828/AP_Hi.pdf

http://ftalphaville.ft.com/2008/11/18/18331/more-us-retailers-report-grim-results/

http://www.ft.com/intl/cms/s/0/b2d837c4-c8e1-11e0-aed8-00144feabdc0.html#axzz2OIHY6KgV